A Wealth Tax is Definitely Constitutional
(…so long as the reform legislation is carefully drafted)
Two leading Democratic primary candidates — Elizabeth Warren and Bernie Sanders — have proposed wealth tax reforms. These candidates claim their wealth tax reforms would raise substantial revenues from the super rich, to fund proposed new spending programs for the middle class. But critics have argued that wealth taxes are unconstitutional, and thus claim that, after review by the courts, the “likeliest outcome is that a wealth tax will raise exactly zero dollars.”
These critics are correct that wealth tax reforms involve constitutional uncertainty. Nevertheless, so long as wealth tax reform legislation is carefully drafted, a wealth tax is definitely constitutional. This blog post briefly summarizes an essay that we just posted to SSRN here (with that essay being a summary of a longer and more elaborate work-in-progress that we plan to eventually publish in a law review format).
The Constitution specifies two distinct paths for assessing a new federal tax. The first path applies to “[indirect] taxes”; “duties, imposts, and excises”; and “income taxes.” This path requires that the federal tax be uniform. That is, the federal tax rates must be the same in every state. All current federal taxes follow this path.
The second path applies to “direct taxes.” This path requires that the federal tax be apportioned, rather than that it be uniform. That is, the federal tax must raise the same revenue, “per-capita,” from every state. For a federal wealth tax, because some states have wealthier populations, this path would require that federal wealth tax rates be set lower in wealthier states and higher in less-wealthy states.
Constitutional scholars disagree about which of these two paths should apply to a federal wealth tax. The first path would be the easiest for Congress to follow. But, as we will explain, the second path is also manageable.
Between 1798 and 1861, Congress enacted five different major tax reforms that levied direct taxes. These direct taxes were not comprehensive wealth taxes, but were taxes on specified forms of wealth, such as real estate (and slaves). The first four of these direct taxes worked reasonably well. But the fifth — the Direct Tax of 1861 — created numerous problems. The reason was the Civil War. The Direct Tax of 1861 was largely successful in raising revenues from the Union states, but questions of what to do about taxpayers in the Confederate states created lingering controversy. As a result, this historical episode “effectively discredited” direct taxes, and Congress has not seriously considered levying a direct tax since 1861 — until now.
Yet modern tools of tax administration and fiscal federalism would make it much easier to levy a direct tax today. We will briefly explain below, by summarizing one approach for how Congress could levy an apportioned wealth tax (and how this approach could be used as a fallback clause in event that the Supreme Court ultimately holds that a federal wealth tax must be apportioned).
Congress could begin by legislating the average nationwide federal rates for the new wealth tax. The apportionment requirement would then result in the state-specific federal tax rates being set lower in wealthier states and higher in less-wealthy states. On its own, this might seem inequitable. But consider that, for the existing income tax, combined federal- and state-level rates already differ amongst the states. For instance, the highest capital gains rate is currently 13.3 percentage points higher in California than in Florida.
Because all existing federal taxes follow the uniformity path, federal-level tax rates are currently the same in every state, with state-level piggyback taxes then making the combined tax rates unequal. By contrast, for a new federal wealth tax following the apportionment path, the federal-level tax rates would be unequal, but state-level piggyback taxes and rebates could then make the combined rates more equal.
Congress could implement this through two steps. First, Congress could streamline state governments’ ability to levy piggyback taxes or rebates for the new tax. (This is already being done with the existing income tax, which is why state-level income taxes use relatively simple forms based on information from the federal-level returns.) Second, Congress could implement a fiscal equalization system to ensure that the governments of less-wealthy states have sufficient funds to rebate the combined wealth tax rates down to the nationwide average levels, to the extent that these state governments opt to do so.
Fiscal equalization systems of this sort already exist in Canada and Australia and have been proposed for the United States. In a sense, existing federal grants to state governments already operate as a form of fiscal equalization, and “General Revenue Sharing” under the State and Local Fiscal Assistance Act of 1972 offered further fiscal equalization prior to its repeal under President Reagan. It would be relatively straightforward for Congress to implement a new fiscal equalization system of this sort as part of enacting an apportioned federal wealth tax. This would provide less-wealthy state governments the funds needed to rebate their residents’ wealth tax burdens down to the nationwide average levels. Ultimately, it would be up to each state’s government to decide how much of a rebate to offer to the state’s taxpayers, or whether to instead levy an additional state-level piggyback tax.
Just as wealthy Californians currently face higher overall capital gains tax rates as compared to wealthy Floridians, different state governments would make different choices with respect to a new apportioned wealth tax, resulting in the wealthy residents of some states having higher tax burdens than others. But this follows from what the founders arguably intended by writing the apportionment requirement into the Constitution for direct taxes, making state governments act as a buffer between state residents and the federal government’s direct taxing power.
Thus, Congress could legislate a federal wealth tax that would definitely survive scrutiny under either the uniformity or the apportionment path. But, then, what to do about the fact that we do not yet know how the Supreme Court would rule as to which of these paths a new federal wealth tax would need to follow?
The solution here is fallback clauses. Both the structure of the Constitution and prior Supreme Court precedent are absolutely clear that Congress can write instructions for what is to happen if portions of legislation are held unconstitutional. The only challenges are that Congress must write such instructions unambiguously and the fallback options must themselves be constitutional. For a new federal wealth tax, this means that Congress should write instructions clearly specifying that if the wealth tax is held to be unconstitutional under the uniformity path then a modified version of the wealth tax designed in accordance with the apportionment path should then go into effect.
Drafting these instructions into legislation would involve some additional challenges beyond what we can explain here. But the overall task is manageable in the context of designing a major new tax reform. The bottom line is that carefully drafted federal wealth tax legislation would be definitely — without any doubt — constitutional, and thus capable of raising substantial revenues to fund new spending programs for the middle class.
-John R. Brooks and David Gamage
John R. Brooks is a professor at Georgetown Law.
David Gamage is a professor at Indiana University’s Maurer School of Law.
